Chapter 9: Risk transfer

Organisations around the world are becoming more aware of the increasing frequency and severity of recall incidents, especially in the food and beverage, toy and automotive sectors. When an incident occurs, the case for product recall insurance as an effective risk-management measure becomes particularly compelling.

Further, product recall insurance can also provide access to experienced and knowledgeable risk professionals and crisis management teams and other specialist consultants, which can help minimise the impact of a recall by increasing the preparedness or, in some cases, prevent it from happening in the first place.

Video: Top misconceptions about product recall

Now former Aon crisis management director Karina Rodriguez-Diaz shares the top misconceptions about product recall and contamination insurance.

Here are a few reasons why uptake of product recall is increasing:

1. A requirement by key customersContractual requirements are a major contributor to the demand for product recall insurance. If, for example, a company is supplying a product to a key customer, quite often in the automotive industry, they will require evidence of product recall insurance.

Many companies supplying European and US automotive manufacturers will have product recall coverage with a limit near $10m. A similar situation exists in the electronics and food and beverage sectors.

2. Recalls – and publicity surrounding them – are on the riseRarely will a week go by without a recall case being reported in the news. Indeed, official figures, across many industries, including automotive, food and beverage and consumer goods, show that recalls are on the rise. (see illustration).

The reasons for increasing recalls are many. Firstly, the speed to market of products is continuing to increase, which can potentially lead to quality issues and, ultimately, product recalls. Second, particularly in the automotive industry, component parts are being shared more widely across different products and brands. The Takata Airbag recall is a great example of this, where 19 different automakers recalled cars to replace Takata’s faulty airbags. Third, increasing technical complexity in products has led to certain products such as cars becoming more susceptible to glitches and defects. Finally, product recalls have increased as a result of consumer protection organisations encouraging customers to report defective products and owing to the wider availability of product information on websites and labelling

3. Increasing regulatory oversightGovernments across the globe have implemented stricter food and product safety protocols to help ensure consumers are protected against injury and harm from products. New regulations and networks include:

Government-led recalls are also becoming more common due to the strengthening of regulation. This has been particularly evident in China over recent years. Recall numbers are also on the rise across the Asia-Pacific – albeit often from a low base – with Singapore and the Philippines both seeing increased activity in this area.

4. The costs are severeProduct recall costs can easily creep in to the million-dollar range, with some even costing more than $100m. It’s not just the cost of a recall that a company must consider, however, but also the effect of a recall on a company’s share price and reputation.

Examples of major costs

Major direct costs

Identification and tracing defective products

Repair, disposal and replacement

Third party consultants

Laboratory tests and other investigative costs

Business interruption, such as a production being closed to re-engineer design processes

Sanitising contaminated factories

Additional expenses, such as hiring customer service professionals to man helplines etc

5. Globalisation and supply chain complexityChinese restaurants in the Americas, sushi in Europe and Swiss cheese in Asia – the benefits of world trade in food come to everybody. We can now eat any cuisine in nearly every country. All of this is possible because shipping, processing, packaging and trading of finished and raw foods is the norm.
While globe trade provides greater consumer choice it also creates new risks, including:

Reduced visibility of risks by manufacturers.
Shipping goods across the world fragments the supply chain.

It becomes more difficult to ensure that ingredients and finished products are safe to eat and use as the responsibility of food and product safety is spread over many different business partners.

Increased imports of components and raw materials can create issues in delivering product safety to consumers

So why aren’t people buying?

Even with such dramatic examples to learn from, and the clear benefits of product recall insurance, many organisations are still unsure of the potential magnitude of financial, regulatory and brand impact from a recall event. As such, take-up of recall insurance remains relatively low.

1. A perception that it’s too expensive
Some of the common concerns and misconceptions of product recall insurance are outlined below.

With rising pressure to increase margins and reduce costs, many manufacturers and component part suppliers in Asia-Pacific tend to view product recall insurance as an unnecessary expense.

Many are buying insufficient insurance limits, allowing policies to lapse, or declining insurance cover in the expectation that a product recall won’t happen to their business.

However, one only needs to look at the negative publicity surrounding recalls to see that there can be a serious impact on brands and reputations. For example, the recent Samsung Galaxy Note7 recall is estimated to have cost at least $5.3bn, with none of this reportedly covered by product recall insurance.

The Samsung example is an extreme case. Typically a recall may cost somewhere between $5m to $30m, rather than billions. However, the fact remains, that a recall has the potential to cause a significant dent in a company’s balance sheet.

2. Confusion between product liability and product recall insuranceOften a product recall event may arise after a company is alerted to a defect through receiving one or more product liability claims for bodily injury or property damage. The manufacturer may then conclude that the defect may not be isolated and recall the product from the market. In this case, the recall, although linked to the product liability loss, would not be covered under a typical product liability policy and would need to be catered for by a specific product recall insurance policy.

Simply put, product liability covers a claim for bodily injury and property damage owing to a product defect. It does not cover recall expenses to mitigate potential bodily injury or property damage that might happen.

Expenses for the recall of any accidentally or unintentionally contaminated, impaired or mislabelled product(s) which resulted in or the consumption of which would result in bodily injury, sickness, disease or death of any person(s).

Expenses for the recall of any actual or alleged defective product which resulted in or has an imminent danger to result in bodily injury or property damage.

Covered loss

Compensation of justified claims and defence costs

Insured’s recall-related expense, such as:

notification of customers

testing/checking

cost of disposal

cost of replacing recalled products or

reimbursement of purchase price

First and/or third-party recall expenses such as:

notification of customers

shipping costs

testing/checking

costs of disposal

costs of replacing recalled products

costs of employee overtime

costs of renting additional warehouse

3. Position in the supply chainThe recall exposure for companies along the supply chain can differ substantially. An ingredient or component supplier will have different recall hazards to a manufacturer of final products. Ultimately, this can influence each company’s perceived product recall risk and impact how they design their insurance programmes.

One area that has become more problematic with regards to this is where a company manufacturers a component that is incorporated into someone else’s product, as opposed to producing a finished item.

Food ingredients such as sugar, flour or soy, are a good example of this. Airbags and seatbelts are another.
If the manufacturer of the final product – such as a car – needs to initiate a recall because of a manufacturing error of the supplied component – such as the airbag – which also poses an actual or imminent danger of bodily injury or property damage, the component part supplier could be charged for the recall costs incurred by the end manufacturer. However, such expenses would only be covered if product recall insurance had been purchased by the supplier.

Underwriting recall risk

Regardless of the industry, it is essential for the underwriter to have a clear and comprehensive understanding of the products and operations of a prospective insured.

What does the manufacturer produce? Is the product presenting a higher or lower risk of a recall?Recalls are quite frequent in the automotive as well as, the food and beverage industry. Within those industries there are certain products that have a greater frequency and severity of loss to a recall. For example, in the automotive sector, critical items such brakes, seat belts, and steering elements would be considered a higher risk than floor mats of interior lighting.

In the food and beverage sector ready-to-eat meals present a higher risk as due to susceptibility to microbiological contamination, such as salmonella. These mass-produced products derived from many different ingredients from a wide variety of suppliers, delivered just-in-time may be transported and/or stored by third party providers presenting a complicated supply-chain and distribution chain exposure.

To whom do they sell?‘Business to business’ companies require a differing approach to the management and communication of a recall compared to a ‘business to consumer’ firm.

What is the company’s turnover?The size of a company as well as sales of specific products is used in assessing a risk and calculation of the premium. In many cases the underwriter would be interested in the size of batches and the tracking of those.

Where are the products sold or distributed?The distribution and sales of products is a factor in assessing the complexity of a potential recall and robustness of a recall plan.

Understanding the supply chain for the company.The underwriter will be looking to get a clear picture about the agreement between the two parties. Concerns include the dependency of the end manufacturer on the parts or components provided. Do suppliers have any insurance and/or any contractual obligations in the event of a recall? Further, what product safety processes does the third party supplier have in place, such as quality checks, recall procedures and plans, traceability and labelling protocols?

2. QUALITY CONTROL

Next we would explore the quality control processes that the insured has in place to understand how they are mitigating the risk of a product recall. This will include gathering information on the following:

What procedures do they have in place?Does the quality assurance programme run from the beginning to the end of the manufacturing process – from the raw material checks to the final product?

Do quality checks extend to conducting tests against things like microbiological contamination, radioactive levels, or foreign materials being present in the products or raw materials? Does the manufacturer audit, review or renew their suppliers, and if so how regularly?

What certification do they have and are they from recognised industry bodies?For example, for the food sector does the company follow HACCP or the GMP standards? For automotive sector, does the company follow the ISO standards, for example ISO9000 and TS16949 standards?

Does the company engage with third parties to test their products?How frequently are these checks done? Is the testing regime due to regulatory requirements or the company’s own internal risk management? Does the company’s customers require the third party testing? What is the frequency of the testing?

Do they follow the safety standards of certain countries where they sell their products?For example, for exporting to the US it would be FDA standards. Whereas for Europe this would be adhering to Product Safety Acts.

3. LABELLING AND TRACEABILITY

Another important area, particularly for the food and beverage sector, is the traceability of products. Effective strategies and technologies in this area can speed up the actual recall and pinpoint which batch is affected and, importantly, how widespread the recall might be. Important factors will include information on:

How can they trace their products?
For example, by date, by batch code, by production line. How do they track their supply chain for specific batches?

How long do they keep production records?

Labelling is a key area: Are the labels reviewed by an internal or external lawyer to ensure they follow the requirements of the countries to which the products will be exported?
Does the label clearly state ingredients and any potential allergens? Is the label in the language of the country to which the product is exported?

4. RECALL PREPAREDNESS

Typically, the more a manufacturer can demonstrate that they have recall plans in place and have communicated this appropriately across the organisation, and tested it, the more comfortable an insurer will be with the risk and therefore the likely result will be a better insurance premium and/or terms and conditions. Factors that help this understanding include:

• Does the company have recall procedures and plans in place?
• Do they do mock or test recalls?
• When did they last do a mock or test recall?
• How frequently do they run test recall simulations?
• Who are the parties involved in the test recall?
• Does the company know what their maximum potential loss and/or maximum probable loss from a recall?

5. LOSS EXPERIENCE

Proof of losses and, importantly, what additional risk mitigation measures or lessons learnt have been put in place as a result, can often mean the risk is priced at a more favourable premium. Typically, information would include:
• Five to 10 years of loss history.
• How has the company mitigated similar future losses?

6. EXTRA REQUIREMENTS

In the case of contaminated products insurance; if the manufacturer wanted the insurance to cover product tampering and extortion, we would also want to understand the security levels at the company, are there any ongoing or previous strikes or riots at the manufacturing plants or warehouses? Are there any wrongful termination lawsuit ongoing?

Why do insurers want so much information?The above list might seem comprehensive, however there are three key factors why insurers will typically ask for this level of detail when underwriting a product recall exposure. These are:

• To appropriately analyse the exposure and accurately price the risk and determine the most appropriate terms and conditions for the specific recall risk.
• To understand trends that might help develop new products and understand correlations that can result in better premium rates.
• And, to manage the insurer’s systemic risk.

What happens if information is unable to be provided?If full information about the risk is unable to be provided it may result in an increase in premium as the underwriter will have to price for the unknown.

How does the insurer use the information?Initially the information gathered from the client, typically through a broker, will be reviewed using several modelling tools and systems to gain a base rating for the risk. Underwriting knowledge will then be applied to the risk rating based on their understanding of the risk, and using their expertise adjusted accordingly.

Ultimately, these factors will impact the premium and the acceptance of the recall risk.

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